Thursday, November 6, 2008

Insurance



Insurance is something that we hear all the time. Car Insurance, Bike Insurance, Health Insurance Personal accident Insurance, there are a whole bunch of insurance products available.

What is Insurance?

Insurance is nothing but an agreement between the insurer (The Insurance Company) and the insured (You) to pay an amount as compensation if any unexpected event occurs. This amount may vary from a few hundred to even a few crores. The maximum amount the insured person can claim depends on the amount agreed upon as per the insurance policy.

Why do Insurance companies provide Insurance Policies?

Insurance is provided only for events that have a small chance of happening. The company would never insure you for something that is bound to happen. Say for example you cannot insure your car if you are going to use it for Racing. Because, the chances of your car getting damaged during a race is far higher than when you drive it on ordinary roads.

Let me explain Insurance with an example. Person X contacts an insurer say LIC (Life Insurance Corporation of India) and take an insurance policy worth Rs. 10,00,000/- health insurance with critical illness cover for a period of 10 years. For Taking the policy, LIC asks X to undergo a medical test and once the test clears X will start paying a premium of say Rs. 15,000/- per annum. The moment X pays his first premium, the policy is in force and if he
gets any health complications then he can claim the insurance.

Assuming after 6 months X meets with an accident and needs to undergo a surgery. The Doctors estimate the cost of surgery at Rs. 2,50,000/- Now X would provide sufficient proof to LIC that he met with an accident and along with the doctors bills, he would submit all documents to LIC. Once LIC validates the documents it would release a payment of Rs. 2,50,000/- to X.
Though the policy is worth Rs. 10,00,000/- LIC is liable to pay X only the amount required for the treatment. Even if the amount is as small as Rs. 100/- LIC is liable to pay X the money. However, if the treatment expenses is say Rs. 11,00,000/- then LIC would pay X only Rs. 10,00,000/- The remaining Rs. 1,00,000/- needs to be met out by X out of his pocket.

This is the concept of Insurance. Insurance is nothing but an obligation for the Insurer to compensate for any unexpected events that may happen to the insured person.

Why do we need Insurance?

There may be scenario's where the loss that we would incur due to some event would be extensive and we would not be in a position to incur the losses. Say for e.g., the only earning member in the family meets with an accident and is incapacitated from going to work for 6 months, what would the family do for their survival? These are the cases where Insurance comes in handy. The insured person can claim an amount corresponding to his disability
losses and use the money to sustain his family until he is fit to resume his job.

Who Needs Insurance?

Anyone who has people dependent on them definitely needs Insurance. The dependent could be your wife & children, or your parents or your minor siblings etc. The purpose of having insurance is to ensure that our dependents are able to lead a decent living even if anything unfortunate
happens to us.

How much Insurance do we need?

If you have atleast one dependent you need to be insured for atleast 5 times your annual income. If your annual salary is Rs. 5 lacs then you need to be insured for atleast 25 lacs. The more the dependents the more the insurance. Take the case of a person who is married and has two children who are in school. He would need atleast 10 times his annual income as insurance
because, in case of any unfortunate event occuring to him, his wife and children would be stranded. The family would need financial support to ensure that they are able to lead a peaceful life. If you have any loans outstanding, your insurance cover has to increase by the same amount.

Lets say Mr. X is married and has a Son who is 10 years old. He is the only earning member of the family. He has a home loan worth Rs. 15 lacs with ABC Bank. His annual income is Rs. 5 lacs per annum.

Mr. X would need an insurance of atleast 65 lacs ((10 * 5) + 15) Ten times his annual salary plus the amount of home loan.

Lets take three scenarios...

1. Mr. X has no insurance at all.

The Bank would want to take possession of the house to recover its loan amount. Hence Mr. X's family would have to move out. Since X is the only earning member of the family, his wife and son have no source of income. They would be stranded and would have to depend on their relatives for their sustenance.

2. Mr. X has insurance but is only worth Rs. 50 lacs (He was smart enough to
get himself insured for 10 times his annual income)

The Bank would want X's family to repay the home loan outstanding amount. Lucky that X is insured for 50 lacs. His wife would pay out 15 lacs from the insurance amount and continue to stay in their house but, the corpus that she has to sustain herself is badly diminished because of the loan amount payment. But definitely this situation is far far better than the previous
one.

3. Mr. X is insured for Rs. 65 lacs or more.

The Bank would want X's family to repay the home loan outstanding amount. Since X is insured adequately, his wife would be able to pay out Rs. 15 lacs comfortably and also would continue to have Rs. 50 lacs or more in her savings using which she can continue to lead a decent living. She can use this money to educate her son and make sure his future is secure.

Now I guess you know the importance of Insurance :)

Types Of Insurance:

1. Health Insurance
2. Disability Insurance
3. Life Insurance
4. Automobile Insurance
5. Theft Insurance
6. Travel Insurance
7. Property Insurance etc

Confusing Investment and Insurance:

A lot of us confuse Investment and Insurance. Investment is something that we save up to use while we are alive. Insurance is something we save up for our family to use once we are gone. The goals of Investment and Insurance are totally different. A lot of us take Insurance policies as investments. This is the reason why there are a whole group of people running behind us
telling us how great their new Insurance policies are.

Let me explain with a simple arithmetic. Assuming you pay an Insurance policy premium of Rs. 25,000/- for a policy that would mature in 20 years The Insurance agent would have told you that the policy is worth Rs. 5 lacs and you would get a bonus amount equivalent to it and hence you would be getting Rs. 10 lacs at the end of 20 years. This is a big amount and obviously most of us would be lured into taking this policy. What do we forget here?

1. A fat portion of the premium we pay in the first few years would be paid to the agent as a commission
2. Every year a portion of your premium (Atleast 2%) would be paid to the agent as a commission
3. The Insurance company would deduct a portion of our premium (Atleast 5%) as mortality charges.
4. The Insurance company can invest only in debt instruments and hence the returns on our investments cannot exceed 8 or 9 % per annum.

Assuming you invest the same Rs. 25,000/- every year in a bank Fixed deposit that earns an interest of 9% per annum, what do you think will be the maturity amount? You wont believe me. It is Rs. 13,62,745/- which is Rs. 3,62,745/- more than what your insurance policy would give you. (Assuming what your agent said was true and you would get Rs. 10 lacs)

You will be wondering how this amount of more than Rs. 3 lacs got reduced. The answer is simple: "COMMISSION". Your Agent eats this amount from your investment and hence you are getting only 10 lacs.

Am I against taking Insurance Policies?

No, Definitely not. The purpose of Insurance is to help our family once we are gone. Hence we should opt for policies that pay our families money if anything unfortunate happens to us. Such policies are called "Pure Term Life Insurance Policies". You pay a fixed premium every year for the next 25 or 30 years and in any unfortunate event the insurance company would pay your
family the insured amount. If you outlive your policy then you would not get any money.

For the same 5 lac insurance policy that we considered above, you need to pay only around Rs. 5000/- every year. Even if you invested the remaining Rs. 20,000/- in bank FD's for the same period of 20 years you would have accumulated Rs. 10,90,196/- which is 90 thousand more than what that policy gave you. Plus you had the same insurance cover for the same duration.

Why do Agents not recommend such Policies to us?

The Answer is simple: "COMMISSION". Such policies have the least commission percentage and hence agents seldom advise us to take such kind of policies. Though these are the cheapest kind of policies with the most benefits for our family, the agents do not advise us because they do not get anything out of such policies.

Conclusion:

Always think before you take an insurance policy. Think if you really need this policy. Think if this is the best policy that suits your need. Do not take Insurance policies for Investment.

Happy Insuring.....

4 comments:

  1. Hi
    Mr.Anand

    I am looking forward for a help from ur end on a LIC policy, I am bit confuse to go ahead on it or not. I am having a LIC policy named Jeevan Anand on my name about 2 years old with 10 lac risk amount for 30 years and I am paying around 33k per annum and my age is 27 years and I am married. And know I wanna go for 1 more policy of LIC Samridhi Plus a ULIP policy for 10 years were I am planned to pay 1 lac per annum for 5 years in this after maturity I get 15 lac minimum as per the LIC consultant advised.

    So I went through your Blog n know I m in dilemma wthr i shud go with SAMRIDHI PLUS or not can U plz advice me on this what shud I do shud I go ahead with ULIP plan as I feel its a short term policy n I get a hand full of amount at maturity or can U please advise me the better option.

    Looking forward for ur reply.

    ReplyDelete
  2. @ MHRWorld Photography

    Thanks for your comments. Appreciate it. And - Reg. this LIC Samridhi Plus ULIP Policy - let me remind you that ULIP policies invest in the stock market and there is nothing called guaranteed returns in the stock market. if the agent says that you will get 15 lacs minimum, ask him for a written confirmation in a LIC Letter head with his and his managers signature that at the end of 10 years you will get 15 lacs and if not, he will compensate for the rest. He wont.

    Actually speaking, agents are not supposed to give such guaranteed returns advise. There is no such thing as a guaranteed return in stock market investment.

    And - ULIPs and stock market investments are long term investment instruments and not short term. With the current stock market scenario - investing in the stock market for short term is nothing short of suicide.

    Ok coming to whether to go or not - is purely your decision. if you answer Yes to two or more of the below points then i think you can go ahead with the investment:
    1. Are you ok with the risk involved in stock market investing?
    2. Do you plan on staying invested for atleast 10 years or more?
    3. Considering the current stock market scenario and considering the fact that the markets may stay this way for atleast the next 2 to 3 years, are you ok if you suffer losses on your investment?
    4. Do you have a pure term life insurance policy that equals 3 or more times your annual salary?

    If your answer to question 4 is a No - Then i suggest you first take a pure term life insurance policy and then think about the ulip.

    Note: I am not advising you against investing in ULIPs. Just want to tell you that they are risky (because of stock market), so make sure you know that before you invest.

    ReplyDelete
  3. Hi
    Mr.Anand

    Thank you very much on ur precious advice on ULIP its very helpful for taking a decision on future investment...as U said about the Pure Term Policy I already enrolled with ICICI iProtect option 1 for 50 lakhs for 30 years were I have 2 pay 5350/- per Annum...

    And after ur reply i spoke to Agent about the guarantee n know he says its 100 month NAV guarantee wch make U guarantee of money 2 times...If not in ULIP do I invest in MUTUAL FUND if Yes then in wch company shud I invest SBI MF, LIC MF, Reliance, TATA AIG, Franklin Templeton, or Bharthi AXA, or HDFC or ICICI wch is more better performer n saver?

    Looking forward for reply

    Once again Thank U for ur kind advice on Term policy.

    ReplyDelete
  4. @MHRWorld Photography

    You are always welcome my friend. 50 lakhs term policy is very good.

    mutual funds are a very good option for investment. i would suggest you choose balanced mutual funds for investments because they invest in stock markets but have a healthy % exposure to debt instruments too which gives a lot of stability in terms of returns.

    And - Mutual funds from HDFC and ICICI have been known to outperform their peers very well because they usually have very good fund managers.

    All the best !!!

    ReplyDelete

© 2013 by www.anandvijayakumar.blogspot.com. All rights reserved. No part of this blog or its contents may be reproduced or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the Author.

Google+ Badge

Google+ Followers

Followers

Popular Posts

Important Disclaimer

All the contents of this blog are the Authors personal opinion only and are not endorsed by any Company. This website or Author does not provide stock recommendations. The purpose of this blog is to educate people about the financial industry and to share my opinion about the day to day happenings in the Indian and world economy. Contents described here are not a recommendation to buy or sell any stock or investment product. The Author does not have any vested interest in recommending or reviewing any Investment Product discussed in this Blog. Readers are requested to perform their own analysis and make investment decisions at their own personal judgement and the site or the author cannot be claimed liable for any losses incurred out of the same.